Fiscal 'space'

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Rebuilding 'fiscal space'

Faced with weaker export prospects, and a likely rise in global
interest rates, developing countries should look to rebuild their
‘fiscal space’, according to a new report just released from the
World Bank. The
recent fall in oil
prices is likely to have created an opportunity for them to do just
that. Many developing countries were forced to implement
expansionary fiscal
policies to counteract the global slowdown - given the difficulty of
implementing a monetary expansion in the face of large public debts.
However, there is now less fiscal space to maneuver.

A key finding in the report is that in countries where debt and
deficits have increased, any net injection of public spending will
contribute less to consumption and national income than it would have
prior to the global slowdown because the high debt levels have made the
fiscal
multiplier effect much weaker. Fiscal multipliers relate to the
ratio of a change in output (ΔY) to a discretionary change in government
spending or tax revenue (ΔG or ΔT). In simple terms, the fiscal
multiplier measures the effect of a change in spending or tax revenue on
the level of GDP. Countries with higher debt levels are
likely to suffer from higher levels of uncertainty and pessimism, and
hence lower levels of marginal consumption following more government
spending or less taxation.

However, the 'good' news is that the fall in oil prices provides an
opportunity for those developing countries relying on imported oil to
rebuild their 'fiscal buffers' given that their governments have less
need subsidise imports of oil. Such subsidies represent a large drain on
public finances.

The report goes on to suggest that well-designed mechanisms,
such as fiscal rules, stabilisation funds, and medium-term expenditure
frameworks, will help rebuild the fiscal buffers and enable developing
countries to better withstand future global shocks.